Classical Economic Theory


The Classical Theory


The fundamental principle of the classical theory is that the economy is self-regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed. While circumstances arise from time to time that cause the economy to fall below or to exceed the natural level of real GDP, self-adjustment mechanisms exist within the market system that work to bring the economy back to the natural level of real GDP. The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices, wages, and interest rates are flexible.


Citation: http://www.cliffsnotes.com/study_guide/The-Classical-Theory.topicArticleId-9789,articleId-9741.html

Summary:

The economy runs itself.
2007-10-26%20Full%20employment%20but%20no%20reward%20for%20Howard%20226.jpg
Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed


Keynesian Theory


Keynesian Economics:
Keynesian theory basically states that the best way to run an economy is through monetary policy. Monetary policy is controlling the amount of money in circulation.

Those who believe in Keynesian Economics think that the government is the one that is supposed to maintain and keep things in order in business. The way that the government maintains the system is by spending and tax breaks. This would stimulate the economy. To curb inflation spending would be cut, and there would be tax hikes when the economy is good.

Citation:
Investopedia





Summary:


Keynesian economics says that supply does not always create demand.
howgoldtransfers.jpg
Monetary policy is controlling the amount of money in circulation.


Aggregate Supply


:the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy.

Higher prices motivate profit-seeking firms to increase output. This is because of diminishing returns and thus rising marginal costs that arise because one or more of the inputs or factors of production does not change in the short run and is assumed to be fully employed at all times. Usually this is fixed capital equipment. The AS curve is drawn given some nominal variable, such as the nominal wage rate. In the short run, the nominal wage rate is taken as fixed. Thus, rising P implies higher profits that justify expansion of output. In the neoclassical long run, on the other hand, the nominal wage rate varies with economic conditions. (High unemployment leads to falling nominal wages -- and vice-versa.)

Summary:

Everything that is planned to be sold




Aggregate Demand


The total demand for finished goods and services in the economy at a given time and price level.

This is the demand for the gross domestic product of a country when inventory levels are static. It is often called effective demand, though at other times this term is distinguished. It is often cited that the aggregate demand curve is downward sloping because at lower price levels a greater quantity is demanded. While this is correct at the microeconomic, single good level, at the aggregate level this is incorrect. The aggregate demand curve is in fact downward sloping as a result of three distinct effects; Pigou's wealth effect the Keynes' interest rate effect and the Mundell-Fleming exchange-rate effect.

Summary:

Everything that is wanted in the market at a certain time



Aggregate Demand/Aggregate Supply Curve Model.

The aggregate demand curve represents the total demand for goods and services in an economy. By defining the aggregate demand curve in terms of the price level and output or income, it is possible to analyze the effects of other variables, like the interest rate, on aggregate demand through the aggregate demand equation.
The aggregate supply curve represents the total supply of goods and services in an economy. By defining the aggregate supply curve in terms of the price level and output or income, we can analyze the effects of other variables, such as the interest rate, on aggregate supply. external image 20090216220434%21Aggregate_Demand-Aggregate_Supply.jpg
Through the combined aggregate supply aggregate demand, or AS-AD, model, macroeconomic theory approaches macroeconomic reality. In this way, the AS-AD model is the centerpiece of evaluating macroeconomic policy decisions.